DRAFT

NOTE: The findings and arguments expressed in this paper are strictly those of the author and should not be construed as representing those of any organization, institution, or agency, public or private.

Defense budgets can be a useful, even critical, indicator of national defense priorities, policies, strategies, and capabilities. The size of a country’s defense budget, the rate of growth or decline in its military expenditures, and what it spends its defense dollars on can reveal much about a country’s strategic intentions and future military plans. Defense budgets can also be a good indicator of a country’s military modernization priorities and therefore its possible future military capabilities. Finally, military expenditures can serve as a gauge of a nation’s defense commitment and resolve, or its potential to threaten others.

Consequently, it is not surprising that Western China watchers are keen to know more about Chinese defense spending. As China looms ever larger in the Western, and particularly U.S., security calculus, concerns over China as an actual or potential military challenge have grown correspondingly. One piece of the “China threat” puzzle is understanding where current Chinese strategic and military priorities lay, and whether the PRC is investing sufficient resources in these priorities to constitute a serious security concern for the West.[1]

In this regard, what insights do we hope to get from analyzing defense budgets and military expenditures? Ideally, such analysis should inform us better as to:

· Intentions and resolve: As an indicator of the country’s determination to modernize its armed forces over the long haul, what are China’s long-term commitments to defense spending? Is Beijing willing to increase defense spending both in real terms and over a sustained period? How does this compare with neighboring states and potential rivals?

· The burden on the national economy: Is China spending an “inordinate” amount of money on defense, compared to other nations? How sustainable are current levels of spending?

· Modernization priorities: Which defense technologies, military research and development (R&D), and arms procurement programs are receiving priority spending? How many of a particular type of weapon system are being produced and acquired? What does this say about current or emerging Chinese military doctrine or strategy? How much is being spent on personnel vs. operations and support (O&S) vs. equipment, all of which indicates different priorities for force improvement and has different timelines for payoffs? Is one area of expenditure starving out of the others?

· Future military capabilities: How much funding is going to which branch or branches of the military? Is more money being spent on the modernizing the navy and air force, and hence on increasing power projection capabilities, or on ground forces and territorial defense, i.e., People’s War? Is the PLA putting more funding into technologies relating to the so-called Revolution in Military Affairs (RMA), particularly information warfare and precision-strike, which could result in increased capabilities to fight an unconventional or asymmetric war?

Seeking Truth From Facts: What Do We Definitely Know About Chinese Military Expenditures, What Do We Think We Know, and What Do We Not Know?

Basically, when it comes to national security and defense, we can see if (and where) a country is putting its money where its mouth is. As such, the strength of defense budget analysis is its use of “hard,” empirical information – i.e., fiscal authorizations, allocations, and outlays – that can be quantified and charted. This information, in turn, can be compared, tracked and trend-lined over time, and subjected to regression analysis, and therefore be used to reveal insights into a country’s plans, priorities, and likely capabilities.

However, before we can use defense budgets and military expenditures to address such quantifiable issues, we must first have the budgetary figures to work with. More than almost any other field of inquiry, defense budget analysis is a highly data-dependent field of study – in other words, it involves a lot of number-crunching. Therefore, it demands having a lot of numbers to crunch, and the more numbers we have, the more detailed (and useful) will be our analysis.

This data issue is the greatest obstacle to constructing useful methodologies for studying and interpreting Chinese defense spending in-depth. Ironically, despite its need for large amounts of data, few areas of Chinese military studies actually have access to less reliable data than defense budget analysis. Basically, we possess only three firm facts when it comes to Chinese defense budgets:

· We know the official “topline” figure for Chinese military expenditures. Every March, as part of its annual state budget, the Chinese release a single overall figure for national military expenditures. In 2000, this figure was approximately 121 billion yuan, or $14.6 billion. We possess similar top-line figures for Chinese defense spending going back to 1950. Consequently, we can argue, with a relatively high degree of confidence, that official Chinese military expenditures have increased significantly in real terms over the past decade. Armed with reasonably reliable data regarding China’s inflation rate (i.e., the national consumer price index), we can estimate that, after inflation, China’s official defense budget has more than doubled between 1989 and 2000, and in particular has risen 58 percent in just the past five years (1995-2000) (Figure 1). From this, we may infer that Beijing is seriously committed to modernizing the PLA and overcoming current personnel, equipment, and O&S-related impediments to fielding an advanced military force.[2]

· We know the official defense budget as a percentage of government spending and of GNP. Since we have the overall figure for the annual state budget and can roughly calculate China’s gross national product, we can determine that during the past decade, the defense budget comprised approximately nine to 10 percent of central government expenditures and less than two percent of GNP. Both figures have fallen significantly from their levels during the 1970s and 1980s, indicating that, even as defense budgets are increasing, military spending is actually a declining burden on the Chinese economy.

· We have a rough breakdown of official defense expenditures. According to Beijing’s 1995, 1998, and 2000 defense “white papers,” the official defense budget is distributed almost equally between personnel, operations and support (O&S), and equipment. In 2000, for example, the exact apportionment was 34 percent for personnel (40.6 billion yuan), 35 percent for O&S (41.8 billion yuan), and 32 percent for equipment (38.9 billion yuan). In U.S. dollars, this equates to $4.9 billion, $5 billion, and $4.7 billion, respectively.

In addition, most Western analysts of Chinese defense spending are reasonably certain that the official budget omits a number of critical expenditures, including (1) research and development costs[3]; (2) arms imports[4]; (3) expenses for the People’s Armed Police and reserve forces[5]; (4) state support for China’s military-industrial complex[6]; and (5) earnings from PLA-run businesses.[7] In addition, we are reasonably certain that some kind of purchasing power parity (PPP) formula should be applied to Chinese defense expenditures, in order to provide a more accurate reflection of its true value in terms of relative spending power. Many goods in the Chinese “defense spending basket” cost much less than in the West: conscription and lower living standards in the PLA saves monies on personnel, while low wages at defense factories depresses the costs of arms procurement. These disparities should be corrected by some kind of PPP multiplier, especially if when attempting to compare Chinese defense spending to military expenditures in other countries.

Unfortunately, after these few facts and reasonable assumptions, reliable data regarding Chinese defense expenditures get much shakier. In fact, the unknowns and the unknowables concerning Chinese military expenditures greatly outnumber our known data. For example, beyond the highly aggregated spending figures for personnel, O&S, and equipment, we lack any further details as to how China’s official defense budget is distributed. We do not know how much funding is specifically going to the army, air force, or navy, how much is being spent on which particular R&D and procurement programs, how many of what kind of weapons (aircraft, ships, tanks, or missiles) are being procured annually, or how much support is being specifically accorded to items like training, logistics, or improving soldiers’ living standards. In addition, we lack such detailed budgetary figures over time, which would permit trend and trade-off analyses.

Compounding this lack of detail concerning the declared defense budget, we do not know how much China’s extrabudgetary military expenditures actually are. For example, while we are reasonably certain that defense R&D costs are not reflected in the official budget, we have no idea how much the Chinese actually spend on R&D.

At the same time, while we are reasonably sure that some kind of PPP exists for Chinese defense spending, we have no clear idea what it actually is; PPPs for China can and do vary widely. As Michael O’Hanlon has stated, “Unfortunately, purchasing-power parity measures are very difficult to compute and inherently imprecise. Among the chief challenges are uncertainty over which goods to place in the ‘defense spending basket’ and which goods to consider strictly comparable between one country and another.”[8]

In the absence of additional hard data regarding Chinese military expenditures, Western analysts have been forced to fall back upon extrapolation, inference, and conjecture in order to come up with “reasonable” guesses as how large extrabudgetary spending is, how it should be valued (i.e., how large a PPP should be applied to the data), how much is likely spent on defense R&D and procurement, etc. Unfortunately, this approach is fraught with many methodological pitfalls. For example, in attempting to calculate a “reasonable” procurement budget, analysts typically factor two “guesstimates” (i.e., how much a particular item might cost and how many might be purchased); basic probability theory should warn us that the resulting budget figure would be a highly unreliable number.

It should come as no surprise, therefore, that these efforts have resulted in a broad range of assumptions of likely Chinese defense spending, which – depending on one’s assumptions regarding inputs, valuations, and PPPs – can vary by as much as 1500 percent![9] Even if one excludes the most extreme estimates, Western calculations of “likely” Chinese military expenditures still differ from each other by nearly 300 percent. This bigger-than-a-breadbox/smaller-than-an-elephant type of analysis does little to help us understand the practical implications of actual Chinese defense spending.

Nor do we possess sufficient detail to make assertions, based on what we know about Chinese military expenditures, as to specific Chinese military priorities, intentions, plans, or procurement. In particular, we have no data as to how defense spending is directly affecting power projection capabilities, training, morale, living conditions, R&D, and high-tech weaponry, etc. Consequently, defense budget analysis provides little help when it comes to assessing Chinese defense modernization efforts and future likely military capabilities. We may argue that higher or increasing defense spending is “threatening,” but we cannot identify specifically where and to what extent.

Unfortunately in the absence of additional budgetary data, there is little we as analysts can do to advance the field of Chinese defense budget analysis. We might press the Chinese to be more forthcoming and transparent when it comes to military expenditures – i.e., to release more detailed defense budgets, along with additional (and more detailed) defense white papers – but we should not too optimistic that this will garner significant results in terms of data.[10] And while there probably exist Chinese-language sources that could provide additional insights and tidbits into the defense budget, these are also unlikely to include the kind of detailed, over-time data conducive to more in-depth budgetary analysis.[11]

We can, however, attempt to improve our methodologies and make our work more intellectually rigorous and honest. Specifically:

· We should discount unsophisticated approaches that simply fix military expenditures at a “reasonable” percentage of GNP. We should also discount analysis based on old, highly massaged data.[12]

· We should avoid politicizing analysis, i.e., “low-balling” or “kitchen-sinking” extrabudgetary expenditures in order to produce a desired budgetary figure. At the same time, we should be careful not to get caught up in groupthink and purposely skew our data to fit the “comfortable middle” of the bell curve.

· We should discount approaches that do not include some kind of PPP formula – just because we do not know precisely what the PPP formula is for Chinese defense budgets does not mean that one does not exist. We should endeavor to come up with a mutually agreed-upon PPP for Chinese military expenditures.

· We should not let politicization and worst-case thinking come to dominate budget assessments. In particular, we need to specifically address why extrabudgetary or increasing military expenditures should be considered threatening and not just take it as a self-evident fact. Likewise, we should be careful when making statements like “Chinese defense expenditures could be as a high as…” since one person’s high-end estimates often become another’s baseline arguments.

· We should attempt to be more interdisciplinary and engage more outside functional experts – particularly genuine number-crunching budgetary analysts – in our research. At the very least, these experts can serve as a sanity check on our methodologies.

· We should attempt more alternative analysis of what we definitely know to be factual about Chinese military expenditures. One possible approach would be to assess how far likely spending levels might go in covering basic defense requirements for such things as basic living standards, training, logistics, and procurement. For example, the declared procurement budget alone amounted to $4.7 billion in FY 2000 – not an insignificant amount, and it would be interesting to see what and how much such a budget could buy.[13] We might also explore whether increased official spending is being offset by cuts in extrabudgetary funding (such as compensation for PLA divestiture or for arms imports).

Above all, we should resist the easy temptation to make the “bottom-line” the crux of our analysis – that is, to give out a single figure of X billion of yuan or dollars as the likely Chinese defense budget and simply leave it at that. In this regard, we are only duplicating the same dilemma that we encounter with the official top-line figure for Chinese defense spending: we fail to provide any reliable indicators of where the money is going and why. In the absence of any further context – e.g., what the Chinese are specifically spending their defense budget on, is it cost-effective (i.e., are they “spending smart”?), what are their spending trade-offs, how does this spending compare to other countries’ military expenditures, etc. – such an approach offers little useful information or analysis.

Finally, we need to be honest with ourselves: Given the current (and likely continuing) paucity of sufficient data, we should acknowledge the severe limitations of our efforts, and we should make especially sure that the consumer also recognizes the considerable uncertainty and the large probability of error present in our analyses and assessments. Until we have more data, defense budget analysis of Chinese military affairs will function best as an adjunct to or as a check on other types of empirical research – areas where the arguments are likely to be more impressionistic and less quantitative.

[1] Recent Western writings on Chinese defense expenditures include David Shambaugh, “Wealth in Search of Power: The Chinese Military Budget and Revenue Base,” paper delivered to the Conference on Chinese Economic Reform and Defense Policy, Hong Kong, July 1994; Bates Gill, “Chinese Defense Procurement Spending,: Determining Intentions and Capabilities,” in James R. Lilley and David Shambaugh, eds., China’s Military Faces the Future (Washington: American Enterprise Institute, 1999); Arthur Ding, “China Defense Finance: Content, Process, and Administration,” China Quarterly, June 1996; Wang Shaoguang, “Estimating China’s Defense Expenditure: Some Evidence from Chinese Sources,” China Quarterly, September 1996; International Institute for Strategic Studies (IISS), “China’s Military Expenditures,” The Military Balance 1995/96 (London: IISS, 1995), pp. 270-275; and Richard A Bitzinger and Chong-Pin Lin, The Defense Budget of the People’s Republic of China (Washington, DC: Defense BudgeProject, 1994).

[2] Recent but unsubstantiated press reporting adds that China will continue to boost defense spending with double-digit annual increases for at least next six years. This could double the annual defense budget to $30 billion by 2005. Lester J. Gesteland, “China Defense Budget Up 15-19% This Year,” ChinaOnLine News, January 31, 2000 (www.chinaonline.com).

[3] Wang Shaoguang asserts that the Chinese “openly” acknowledge that R&D spending is accounted for under other areas of the state budget. Wang, “Estimating China’s Defense Expenditure.”

[4] During most of the 1990s, China imported an average of $775 million worth of arms every year. U.S. Department of State, Bureau of Verification and Compliance, World Military Expenditures and Arms Transfers 1998 (Washington, DC: U.S. Department of State, 2000), p. 129.

[5] PAP expenditures are believed to be paid for out of central government expenditures on “administrative expenses,” while the costs of PLA reserves are borne out of provincial budgets.

[6] Official defense budgets likely do not include the costs of direct subsidies to Chinese defense industries or (in more recent years) forced loans by state-owned banks to arms factories (many of which end up having to be written off as nonperforming.

[7] Until the forced divestiture of most PLA-run commercial enterprises in late 1998, profits or budgetary offsets from these activities (e.g., farms, factories, services, hotels, etc.) could be counted as additional sources of revenues for the military. It is still unclear how many PLA-owned business were actually sold off (most PLA-run farms were exempted, for example), how many are still secretly owned by the Army (e.g., through dummy partnerships), and how many divestiture orders were simply ignored.

[8] Michael O’Hanlon, “The U.S. Defense Spending Context,” in Leon Sigal, ed., The Changing Dynamics of U.S. Defense Spending (Westport, CT: Praeger Press, 1999), p. 14.

[9] Wang argues that likely Chinese military expenditures in 1994 were roughly $10 billion, while a RAND report put this figure at nearly $150 billion.

[10] At the same time, given what little concrete data we have regarding Chinese military spending, almost any additional information can illuminating. For example, with information in the 2000 defense white paper, we now possess data on the PLA budget for personnel, O&S, and equipment for four years (1997 to 2000). Even a cursory analysis of this data reveals some interesting facts:

· While all three areas of military spending have remained roughly equal to each other, personnel spending grew only 39 percent between 1997 and 2000, while the equipment budget rose 52 percent over the same period, and the O&S account increased 58 percent.

· Despite assertions that the lion’s share of the recent growth in Chinese military expenditures has gone toward improving PLA soldiers’ standards of living, the personnel budget has, in fact, secured only 26 percent of all additional military spending since 1997. Thirty-eight percent of these additional monies went to O&S spending, while the equipment budget received 36 percent.

[11] David Shambaugh and Bates Gill have identified a few Chinese sources on the defense budgeting process, but these appear to be overviews of the budgeting process and budget management, rather than detailed accountings of military expenditures. See Lu Zhuhao, ed., Zhongguo junshi jingfei guanli (Chinese Military Expenditure Management) (Beijing: Jiefangjun Chubanshe, 1995); Zhongguo junshi caiwu shiyong daquan (Complete Practical Guide to Chinese Military Finance) (Beijing: Jiefangjun chubanshe, 1993); Liu Yichang and Wu Xizhi, Guofang jingjixue jichu (Basics of Defense Economics) (Beijing: Junshi Kexue Chubanshe, 1991).

[12] I specifically refer here to the ACDA/State Department approach to calculating Chinese military expenditures, which is based on original data and formulas (particularly when it comes to calculating purchasing-power parity) that are at least a decade old. In fact, ACDA by its own admission states that its estimations of Chinese military spending “should be treated as having a wide margin of error.” World Military Expenditures and Arms Transfers 1998, pp. 203-204.

[13] For example, Bates Gill argues that, at such a level of funding, the Chinese could conceivably afford a moderate-to-high level of procurement (e.g., several dozen fighter aircraft, five to 10 surface combatants, two to five submarines, and several hundred missiles over a five year period). Additionally, a study by the Defense Science Board calculated that a developing country could acquire a reasonably high capacity for high-tech/RMA-type warfare – e.g., information warfare, integrated reconnaissance-strike platforms, precision-guided munitions, ballistic and cruise missiles, submarines, and sea-mines – with an investment of only $20 billion over a 10-year period ($2 billion a year). Finally, if we assume that the double-digit real increases in recent defense budgets will continue, the equipment will increase by a significant amount every year. Gill, “Chinese Defense Procurement Spending,” pp. 220-223; Defense Science Board Summer Study: Investments for 21^st Century Military Superiority, Executive Summary Briefing (Washington, DC: Office of the Undersecretary of Defense for Acquisition and Technology, November 1995), pp. 9, 11.